Written by: Rebecca H. Williams, CFP®

A family came into my office last week to talk to me about creating a Special Needs Plan for their son who is living with Autism. The family wanted to retire and live off the father’s pension and retirement funds and leave the mother’s IRA directly to their son by designating her son’s Special Needs Trust as the primary beneficiary of her IRA. This sounds good in theory, and kudos to the family for designating his Special Needs Trust as the beneficiary and not their son directly (leaving assets directly in a child’s name could be disastrous if he or she is receiving means-tested government benefits)! But is there a problem with this strategy?

When a retirement account (such as an IRA) is left to a trust there are a few things to consider. When the holder of an IRA reaches age 70 ½, the IRS will require he or she to start withdrawing certain amounts of money from their account every year based off of their life expectancy. These are called “Required Minimum Distributions” (RMDs). If the account owner dies before he or she has begun their RMD distributions, then the trustee can elect to take the RMDs based off of the eldest beneficiary’s life expectancy. This can be a more favorable tax strategy than taking the IRA in full or over a shorter period of time. The trustee will distribute the RMDs to the beneficiaries through what is called a conduit trust. However, this may not be an appropriate strategy if your child is receiving means-tested government benefits as these payments would most likely dis-qualify the child from invaluable programs such as SSI (Supplemental Security Income) and/or Medicaid (known as AHCCCS in Arizona).

In lieu of a conduit trust, the trust could be drafted as an accumulation trust. This type of trust would allow the trustee to let the distributions accumulate in the trust instead of paying them out to the beneficiary so they can be used at a future date for the supplemental care of the child. When creating a Special Needs Plan, this type of strategy, in most cases, would be the most advantageous way of disbursing retirement funds for a child living with special needs receiving means-tested government benefits.

Now, we have to take this one more step further because the family’s wish was that after their son passes away, any trust assets remaining were to be donated to a charity that has been a tremendous resource to them and their son. Leaving assets to a charity is quite common in Special Needs Planning as families that receive support and services through charitable organizations wish to leave something to them in the future as a “thank you.”

In order for an accumulation trust to take advantage of the stretch out provisions, the trust must qualify as a “look-through trust.” Among other requirements, a look-through trust must have a designated beneficiary. In order for a beneficiary to be “designated,” he or she must be living at the time of the account owner’s death and the beneficiary must be able to receive the distribution outright. Well, as we just discussed, a child with special needs cannot receive this outright distribution without the risk of losing means-tested government benefits and the charity is not a natural person. So what do we do now?

Check back with my blog next week to learn about possible solutions to this conundrum!

-Rebecca H. Williams, CFP®

March 20th, 2014

*Nothing in this blog should be taken as legal or tax advice. For advice in those areas, please consult your own legal or tax professional.